Schelling points and health insurance

In an attempt to tamp down rising prices, the Obama administration is setting a 10% maximum increase for health insurance rates, above which insurers would have justify the increases based on higher costs. Starting in 2012 they will set different rates for individual states. I don’t know if there is any literature on this in health insurance, but there is evidence that when regulators set price points it can serve as a focal point, or “Schelling point” for economist Thomas Schelling, for collusion. Here is how Knittel and Stango describe the theory:

In practical terms, the problem of tacit collusion often reduces to one of successful coordination.Firms can resolve the coordination problem in many ways; one such way is through the use of a focal point. The theory of focal points dates at least to Thomas Schelling (1960), who noted that in simple games with many equilibria, agents can quite often recognize a focal point and use it to coordinate. In one of his more well-known examples, Schelling discusses the problem of two people simultaneously choosing a common location (in which to meet) in New York City. Given that the game possesses an inﬁnite number of equilibrium location-pairs, we might expect the odds of successful coordination to be quite low. Nonetheless, in practice most people who play the game choose a well-known spot—such as Times Square or the Statue of Liberty—and can successfully coordinate. In situations where ﬁrms set prices, it is often suggested that the “clustering” of prices occurs at certain natural focal points (e.g., $9.99).

Like I said, I have no idea whether this would or has occurred in health insurance markets. But regulators should certainly consider it a potential cost to setting prices.

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